bediscountedinvalue;inotherwords,adollarincashmay
be valued at less than a dollar by the market.
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1.Thecashheldbyafirmisinvestedataratethatislower
than the market rate, given the riskiness of the investment.
2.Themanagementisnottrustedwithalargecashbalance
because of its past track record on investments.
Cash Invested at Below-Market Rates
Thefirstandmostobviousconditionoccurswhenmuchorall
thecashbalancedoesnotearnamarketinterestrate.Ifthisis
thecase,holdingtoomuchcashwillclearlyreducethefirm’s
value.While mostfirms in theUnitedStatescaninvestin
governmentbillsandbondswitheasetoday,theoptionsare
muchmorelimitedforsmallbusinessesandinsomemarkets
outsidetheUnitedStates.Whenthisisthecase,alargecash
balanceearning less thana fair rate ofreturn candestroy
value over time.
ILLUSTRATION 10.3: Cash Invested at below market rates
InIllustration10.1,weassumedthatcashwasinvestedatthe
risklessrate.Assume,instead,thatthefirmwasabletoearn
only 3% on its cash balance of $200 million, while the
risklessrateis4.5%.Theestimatedvalueofthecashkeptin
the firm would then be: